Environmental Valuation

Hedonic Pricing Method

18/02/09 Carlos Ferreira 1

 Revealed Preference
● Goods are composed by a bundle of attributes
● Consumer utility results from the combination of
all attributes of the good...

● Consumer's WTP is a function of those

attributes
● We should be able to model WTP for a
particular good as a function of the levels of
each attribute
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 Determining the implicit price of the
environmental good
1.Choose a market-priced good whose price is
influenced, among other things, by the
environmental good/liability.
2.Measure, as accurately as possible, the
quantity of the all characteristics that determine
the price of the good (including the
environmental good)
3.Regress the Utility function

NOTE:
18/02/09 ΔU ≈ Ferreira
Carlos WTP 3
 Markets used
● Housing (property)
● Housing (renting)
● Wages
● Rationale: there's an implicit value to environmental
amenities, which impacts market prices
- Individuals are WTP more for a house in a location
where env. amenities are better, ceteris paribus.
- Individuals are WTA working in environmentally
risky/unpleasant conditions for higher wages, ceteris
paribus.
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 Utility Function:
Housing Property Market
P = f (H1, …, Hm; N1, …, Nn; A1, …, Ap)
H = housing characteristics

N = neighbourhood characteristics

A = environmental characteristics

U = f (H, N, A), subject to I = PG.G + PH.H

G = Other Goods the subject consumes

Considering the Housing Market is in equilibrium, PWTP = PWTA, and utility

constant (at W*), we obtain the house price acceptance function:

PWTP = f (U*, I, A, PG)

Differentiating with respect to the specific environmental amenity (A) and
maintaining utility constant at U, we obtain the willingness to pay for
improvement in A.
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 Problems with the model
● Assumes equilibrium in the relevant market
● Omitted variable bias
● Error of measurement bias
● Multicollinearity
● Heteroscedasticity
● No specified Functional Form
● Market segmentation
● Expected versus actual characteristic levels
● Attitudes to risk
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 Example

Hedonic Valuation of Marginal Willingness to Pay

for Air Quality in Metropolitan Damascus

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 Objectives

1. Estimate the MWTP for air quality improvement in

Damascus;
- high levels of Total Suspended Particulate (TSP)
2. Test the validity of applying the HP method in
Damascus
- high variation in pollution in different areas
- only two types of common housing
- developing country
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 Market Scope

● Traditional housing (rarer, more expensive,

seldom transacted) excluded from the analysis
● Two small districts (elite, exceptionally
expensive) excluded from the analysis
● Used two kinds of property value: price of the
house (stock variable) and rent of the house
(flow variable)

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 Data Issues
● Data on property values not readily available
● Need to interview residents to obtain property
values, incomes and structural quality
● “Expert advice” by local real estate agencies
● TSP values are the average of the minimum
and maximum concentration read in late
Summer 2000.
● Data on neighbourhood location and
accessibility directly observed
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 Functional Form and Variables
ln(PRICE) = ln(AREA) + ln(ROOM) + ln(FLRLEV) + HQSTR + LQSTR + LIGHT + DNBR +
+ LHMG + ln(HEALTH) + ln(CENTER) + ln(INCOME) + ln(TSP)

Functional form chosen for

● Simplicity
●
Highest adj. R2 (0.85)
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● Signs and magnitudes of coefficients conform to expectations
 Results
● The Marginal WTP for a unit-decrease in TSP is
approximately $60.00
● The author considers such value “reasonable”
● The study has demonstrated the feasibility of
using the HP method in the context of
developing countries.

However, for all its strengths we believe the

study deserves a further critical appreciation

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 Criticisms
● Variables Used
- Price: mixing property and rental markets
- TSP: usage of min-max average values; data
pre-dates study by some years; other types of
pollution ignored – valuable proxy?
- Structural quality: obtained through home-
owners and realtor's descriptions
● Criteria for choosing Functional Form is
somewhat loose
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 In conclusion
● HP method is deceptively simple
● A sturdy theoretical approach
● Various practical considerations
- Variables used
- Functional Forms
● Results very sensitive to inefficiencies in the market
considered
● Better at evaluating the effect of policies ex-post than
at predicting them
● Presently, the scope for usage seems somewhat
limited
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 References
● Alsherfawi A., M. (2005). Hedonic Valuation of Marginal Willingness
to Pay for Air Quality in Metropolitan Damascus. Forum of
International Development Studies, no. 30: 23 – 34.

● Garrod, G & Willis, K. G. (1999). Economic Valuation of the

Environment. Cheltenham: Edward Elgar.

● Hanley, N., Shogren, J. F. & White, B. (2007). Environmental

Economics in Theory and Practice. Hempshire: Palgrave Macmillan.

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